Analysis of current economic conditions and policy

Finding compromise

President Obama won a second term in office yesterday, receiving 50.3% of the popular vote But the Republicans held control of the House of Representatives and Americans remain deeply divided. Historically, the party in control of the White House loses some congressional seats in the midterm elections. That means that any legislation passed into law over the next two years, and likely the next four years, is going to have to be agreed to by both a Democratic President and a Republican House.

Perhaps the Democrats and Republicans will face up to the fact that, for better or worse, we’re stuck rowing the same boat together for the foreseeable future, so it’s time to strike a Grand Compromise setting the United States’ long-run fiscal house in order. Any objective observer can see that this calls for both tax increases and entitlement reform. Perhaps some leaders on both sides will emerge from the embers left by the election wars to carry such a vision into action. But based on what I have seen from the key players so far, I personally am not expecting to see that happen.

Another idea is to try to break the problem into smaller pieces. Can we at least identify a few very limited measures that we could all agree on? Let’s start with the fiscal cliff. (Please!) How about submitting legislation tomorrow for a one-year extension of the current patch for the Alternative Minimum Tax, and vote the AMT patch up or down as a stand-alone proposition? Next maybe try a one-year extension of the existing payroll tax levels, again yes-no all by itself. If we could just agree on those two items, it would take $300 B out of the $720 B shock referred to as January’s fiscal cliff.

The same principle could be applied to one-year extensions of the Bush tax cuts– break them down into their individual elements and vote on them one-by-one. Do we keep the 10% bracket for another year, or allow it to rise to 15%? Keep 25%, or raise to 28%? And so on down the line. Any single extension that the Democrats and Republicans can’t agree on automatically reverts to the pre-Bush values, following existing law.

Now, Republicans might naturally see this strategy as divide and conquer, because the outcome would obviously be that taxes on the richest Americans would go up as the outcome of this process. There also is the more difficult issue of how to reach an agreement with Republicans on the debt ceiling.

My answer to this is, how about trying the same strategy on the spending side? For example, before going into extending any of the Bush tax cuts, decide on the defense budget, again as a stand-alone measure. Obviously this is going to require some real compromise– the outcome will have to be more than the Democrats want and less than the Republicans want. But the Republicans would view it as a more favorable outcome than if no agreement is reached, since the status quo calls for a 9.4% cut in defense spending.

For that matter, breaking spending on other categories into individual pieces would give the Republican House significantly more power. For example, if funding for Planned Parenthood or specific regulatory agencies become stand-alone line items to which the House has to give its approval, the Republicans are brought in on some of the issues on which they hold the strongest views. More broadly, the essence of pork barrel spending is the agglomeration of the pet projects of individual representatives. The more that spending measures can be broken down into separate stand-alone consideration, the more likely it is that the outcome would be in the overall public interest and serve the principles of fiscal prudence and democratic rule.

When I personally face a challenge that looks insurmountable, the strategy that works best is to try to break it down into manageable pieces. Is there some reason the same principle wouldn’t work at the national level?

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39 thoughts on “Finding compromise”

“Next maybe try a one-year extension of the existing payroll tax levels, again yes-no all by itself.”

No, no, and no!!! Stop trying to supplement wages that are not high enough with more gov’t debt because lower and middle class workers stopped going into private debt. The solution to too much debt is not more private debt or more gov’t debt. I know this is difficult for economists to understand.

I worry that this gives the median voter in the U.S. too much credit. That median voter really does want lower taxes and more spending, even as they also want balanced budgets, at least in the abstract. It seems like you have to do at least some picking a bottom line and working back to it, rather than just expecting that going line by line will get you to the right place.

Put another way, the median voter is likely to avoid the fiscal cliff, but the leaders of both parties are right to be reluctant in turning over too much control to the median voter, who in the end doesn’t have a coherent and sustainable long- or even medium-term plan.

I think the problem with all of the “grand bargain” achievement strategies is that the budget shortfall primarily falls on the revenue side and there is one party steadfastly opposed to fixing that side of the balance sheet; Americans overwhelmingly support the spending programs were currently have, but tax revenues are currently insufficient to pay for them. Over the long run, growth in health care spending unquestionably needs to be reined in as a share of GDP, but that is not only a public sector problem. For Democrats, reforming entitlements means finding a way to rein in cost inflation, not simply shifting the burden onto individuals, and the Republicans have exhibited nothing but hostility toward measures intended to do that.

Interesting item in the WSJ today. Interest rates on short term ExxonMobil debt (due in December, 2013) are slightly below comparable US Treasury debt. Given what is happening to the value of existing Southern European government debt, this might be the start of a very worrisome trend for the US.
In any case, my suggestion would be to abolish the highly regressive Payroll Tax (used to pay for Social Security & Medicare) and replace it with a tax on retail energy consumption, combined with a high deductible flat tax on income and combined with fundamental entitlement reform.

@Mitch
“budget shortfall primarily falls on the revenue side”
By immutable laws, it falls equally on both sides. Spend less, and you need less revenue; spend more and you need more revenue.
To say that it falls “primarily” on the revenue side is to beg the question, by assuming that the spending cannot, or should not, be cut. The same problem would happen if I said it fell “primarily” on the spending side. I am assuming that revenue cannot, or should not, be raised.
Neither position is an argument, just an assertion wearing the clothes of an argument.

The Republicans have sworn not to increase revenues so the only alternative is just to wait to January and let all of the tax cuts expire. This gets the budget closer to long term balance which requires higher revenue to support very popular social services that simply are not going away. From that long term balance it is possible to bargain backwards for temporary stimulus, for example trading a fix for the AMT for a short term extension of the payroll tax cut.

‘To say that it falls “primarily” on the revenue side is to beg the question, by assuming that the spending cannot, or should not, be cut.’
Keep in mind that the side reluctant to raise tax revenues (Republican) vigorously opposed any reductions in defense spending. And when push came to shove, their Presidential candidate railed against the ObamaCare reductions in future Medicare expenses. Simply put – the Republicans have been practicing fuzzy math when it comes to budget issues for over 30 years. If defense spending, Social Security, and Federal health care expenditures are literally taken off the table – there is very little left to cut.

Why entitlement reform?
The Social Security trust fund, together with payroll taxes, is sufficient to cover program benefits for more than the next 20 years. Moreover, assuming no additional funding, currently scheduled payroll taxes can provide benefits equal to those now provided, even adjusted for inflation, for the indefinite future. Given all the real economic problems we truly must address now, there is no legitimate argument for even considering Social Security modifications until the economy is fully back on its feet and long-term costs and revenues can be more accurately projected.
The Medicare trust fund was actually “going broke” when Pres. Obama took office, due in large to changes pushed through by the Bush administration. At that time, the trust fund was projected to be exhausted by 2016. However, the ACA (“Obamacare”), rather than taking the much vaunted $716 billion out of Medicare, actually added that amount to the Medicare trust fund; which is now projected to last until 2024. In one fell swoop, two thirds of the Medicare shortfall was eliminated. Eliminating the remaining one third could be even easier; for example, now that the ACA will protect older working Americans, we can in good conscience synchronize Medicare eligibility dates with those for Social Security. The relative ease of these Medicare fixes, and the fact that the small Social Security issues remaining are far beyond our legitimate planning horizon, why then all the hysteria about entitlements eating our children and grandchildren? In a word—TAXES.
Everyone knows that Ronald Reagan reduced income taxes (more than one half for the wealthy); what is less commonly understood is that he extensively offset this by raising payroll taxes(more than double for most self-employed). Today, most American families pay more in payroll taxes than they do in income taxes. Between 1946 and 1981, income taxes averaged 12(+/-1)% of normalized GDP. Reagan reduced income taxes to near 9%. Clinton increased them back to 12%; and Bush/Obama reduced them again to 9 %( and below). However, on budget expenses (which exclude Medicare and Social Security) have remained 12(+/-1)% of normalized GDP throughout. The deficit in income taxes has been financed by borrowing, largely from the Social Security and Medicare trust funds. When Clinton raised income taxes back to 12%, this eliminated the on budget deficit. The CBO projected that this, plus the Social Security and Medicare surpluses, was enough to pay off the entire US debt before the Social Security/Medicare trust funds would have to be amortized for beneficiary payments, all without having to raise any taxes to pay for the amortization of those trust funds. Like Reagan before him, Bush took those excess payroll tax receipts and gave them “back” as income tax reductions, heavily weighted to the wealthy–who didn’t create those surpluses in the first place. By doing this, Bush guaranteed that income taxes would have to be raised in order to amortize the trust funds. Although the Republicans like to talk about those “47%” who in large part pay only payroll taxes as being supported and subsidized by those who pay income taxes, the truth is the opposite; ever since Reagan, income taxes have been subsidized by payroll taxes; and the failure to raise income taxes to pay back that subsidy, is to steal the money that middle-class workers have had taken out of their income to pay for their retirement.
Hence, the only problem we have with entitlements is paying back the money that we borrowed from the Social Security and Medicare trust funds. This requires that we raise income taxes in the short term to 12% to cover normal on budget expenses. And, as soon as the economy recovers, we must raise taxes above 12% to pay back the trust funds. This is why the Republicans refuse to discuss raising income taxes; they would much prefer to steal workers retirement funds, and reduce the entitlements paid for by them. We do not have an entitlement problem, we have a Republican problem.

@ThomasL
Perhaps you should have continued reading past the semicolon: “Americans overwhelmingly support the spending programs were [sic] currently have, but tax revenues are currently insufficient to pay for them.” Based on polling data, people support “spending cuts” in the abstract, but when presented with specific programs tend to be much more in favor of today’s level of government services. That is an argument for keeping similar levels of spending.
Alternatively, you could look at what has happened since the last time the federal government ran a balanced budget (since ostensibly that’s the end goal here). Since 2000, revenues have been slashed through a pair of tax cuts (2001 and 2003), while spending has risen via higher defense outlays (Iraq, Afghanistan) and a new Medicare program (plus the cyclical budget deficit associated with lower economic output and automatic stabilizers such as food stamps, but these were not policy changes implemented in the past decade). The defense increases should decline as troop drawdowns occur, but the revenue declines will be permanent (setting aside their expiration for the moment). Again, looking at expressed preferences for government services, this places the onus on the revenue side.

Are more one-year extensions really the answer? When we only plan tax rates for one year at a time, doesn’t that raise uncertainty and discourage long-term planning? I always though the number one rule of public finance regarding tax cuts was to make then permanent. Temporary tax cuts have little stimulative power and don’t really change peoples’ behavior.
Enough with the short-term. Let’s sit down and work out a long-term plan. Then companies can make reasonable investment and hiring decisions.

Republicans have to face the reality that this was a massive loss, much worse than the numbers show. Republicans maintained control of the House but that is perhaps the worst thing that could have happened.
The House is essentially irrelevant. No “conservative” bill is going to make it to the Senate floor. Harry Reid is even making plans to limit the Republicans ability to filibuster. The House has passed bills to deal with the fiscal cliff but all of them have been bottled up and not presented to the Senate. The House will only have a bill accepted if it comes from President Obama and they agree with his policies. If the House resists the fiscal cliff is coming no matter what. Taxes are going up and massive spending cuts will be put in place. The House is impotent.
But the impotence of the house is not the most as bas as the political implication. The House is going to receive the blame for every bad decision and bad result that happens over the next few years. Just the very presence of a Republican majority in the House makes it a target and a scape goat.
Republicans have totally been emasculated. They will do well to hold the House in the mid-terms and if they do they will lose massively in the next presidential election.
There will only be bipartisan action is the Republicans totally submit to the Democrats. That will probably happen, and it will simply play into the horrible situation facing a seriously wounded party.

More/Less Taxes, spending, recession or not, I just want a legitimate path towards a balanced budget. But these jokers can’t see the forest (bankrupt US Gov) from their own pet projects, so I expect more deficits until the only option is massive decrease in Gov. spending/increase in taxes, leading us into a much much much greater cliff than these bozos can even imagine, screwing themselves and their own constituents in the process.

bmz has it largely right. We shouldn’t just lump “entitlement” programs under one category called “SocialSecurityMedicareMedicaid.” They are three large programs with very different problems. Social Security’s problems are relatively small and manageable. It’s mainly due to the fact that historically 90% of wage income was liable to the FICA tax. Today that is down to 70%. Increase the FICA limit and “presto!”, no more problem. For those who bothered to read the footnotes to the debt commission’s report will remember that even though the commission recommended raising the retirement age, they agreed that this had virtually no impact on the debt problem. They just thought it would be a good idea on its own merits and went beyond their portfolio. And in the case of Medicare some parts are broken and some aren’t.
On the government consumption and expenditure side of things the big elephant is DoD spending. We have to scale that back. On the transfer side the big elephant is rising healthcare costs under Medicare & Medicaid, but those costs are due to demographics (can’t do much about that unless you want to institute real death panels) and medical costs in general. Simply cutting benefits doesn’t really solve the problem because we would be spending the same percent of GDP on healthcare. Ultimately we are going to have to cut the incomes of healthcare providers (i.e., doctors, Big Pharma, hospital administrators, medical labs, etc.). A good place to start would be cutting that component of medical income that smells like economic rent. We will also have to ration healthcare for the terminally ill to basically pain management. No more heroic efforts to keep a 90 year old comatosed patient “alive” for another 4 weeks in ICU.

Somehow, the idea that there are only two aspects to the budget issue has blocked other thinking. Raise revenue or cut spending. It is a problem of framing.
When you believe that you can only tax more or cut spending you fail to get to root cause for many of the government programs, to wit: the programs are bloated, inefficient, and wasteful.
Now the simple view is that when you simply cut spending you fix the bloated, inefficient, and wasteful aspects of these programs. That would be incorrect. You may reduce the scale of the issues, but you have not addressed the root causes… and you deliver less as a result.
Medicare studies show that there is somewhere between 10-20% waste/fraud built in. Presume it is 20% and you cut spending by 10%. You haven’t reduced the waste and fraud relative to the total spending. You’ve just reduced what the program delivers. Cut the waste and fraud in half and you can cut spending by 10%, not increase revenues, and deliver the same amount of services.
So, while those who say the number show a need for $X tax increases or $Y spending cuts may be technically correct, they are process/product incorrect.
I would venture a guess that at least 10%, probably more, of the federal spending is waste/fraud related and could be fixed. It might take some creativity not necessarily endemic in the government to actually accomplish this mighty feat of discipline, but it could be done without needless pain.

Thank you BMZ for eloquently describing the predation of payroll taxes by the denizens of the Laffer curve. In the same vein, I appreciate the comments from 2slugbaits about American healthcare.
Personally, I have no illusions about the power and influence of the defense and health delivery industries. They will continue to collect their rents and their lavish lifestyles until the rotting bottom drops out of the economy.

As long as Mitch McConnell retains his influence in the Republican party, we can expect that the legislative end of government to remain in park. There’s a reason for this disfunction: RACISM and CHAUVENISM… It animates a republican agenda that is anti-immigration, anti-gay, anti-abortion, and anti-social. While in the short-run, this strategy can deliver congressmen and senators in off-year elections, in the long-run it will prove to be disaster…. We’re getting exactly what the oligarchy wants- No Action. Keep the tax privileges in place. Don’t prosecute corruption, Don’t rearrange the deck chairs on the sinking ship of state.

While this will piss a lot of Democrats off, Obama should support a 2 year extension of all tax cuts while letting the spending cuts go through, if even reducing DoD ones a bit.
It puts the ball in the Republican corner. The Obama recovery turns into the Republicans recovery, or not.
While this is going on, the Democrats can essentially destroy the filibuster in the Senate…………

Not likely. You’re asking the Republicans to give up one of their best bargaining chips at the outset. They’ll hold the AMT adjustments hostage unless they get something valuable in return. Now, if you package the defense cuts with the AMT adjustment, they might be willing to bargain. So, adjust AMT for an only 2% cut in defense, with the remainder of cuts to be made up in cuts on the rest of the government – would probably be their starting position.
And the payroll tax cut is already history. Both sides have indicated it’s time to end it.
I think the best we’ll be able to do before January is an adjustment to the AMT with some changes to the spending cuts. The AMT change mostly has to happen before the end of the year. The rest of the discussion will have to happen after we go over the cliff, when the Republicans will be able to say with a straight face that they didn’t vote to raise taxes. The tax increases happened automatically, and they did their best after the fact to put back tax cuts.
But watch them hold *everything* else hostage to keep the tax cuts for over $250,000 households. That’s the part they really care about.

The “Fiscal Cliff” ends any macro concern about Federal debt.
Thus Congress and the President only need to talk about how to prevent us from falling back into recession.
Congress and the President could also, optionally, talk about reworking sequestration cuts into intelligent spending cuts of the same magnitude to the same departments. But I suspect that DC will be short on intelligent solutions for a few years. [Sigh]

Alas, finding compromise implies that there is a consensual agreement on the nature of the problem(s), and a clear understanding of mutual cost and benefits.
We are moving past, politically, and increasingly socialy, the point where it’s “reasonable people may disagree”, to where my values, ethics and morals are right, yours are wrong.

Democrats might accept a long-term extension of the Bush tax cuts for the wealthy in return for a gradual reduction in tax expenditures for the wealthy that would partially offset, then fully offset, then more than offset the lower rate. That would allow the Bush tax cuts for middle class to stand or fall on their own merit.
For a more long-term solution, I would support legislation that requires a series of specific spending cuts and tax increases. Opponents would be guaranteed one chance to stop a specific cut/increase through an up or down vote in each house on a counter proposal. If, for example, one of the proposed cuts were a trillion dollars for Medicare, Democrats would be guaranteed an up or down vote on legislation to replace part or all of this cut with a tax increase.

The ten year trailing average of income tax (corp plus individual) revenues are at the lowest level in 50 years. Current year estimated income tax revenues are about 1% of GDP below the average since 1981 (intentionally switched framework to the neoconservative era rates). That gives you a metric to illustrate there is a revenue side problem.

Pair that with the fact that Social Security over the past 30 years has generated a $2.7 Trillion transfer payment to general government, a flow which has been known for years to slow down and reverse over the next 30 years. It is slowing down now, meaning that other revenue sources are needed simply to cover general government obligations, unless we are willing to make substantial cuts through all of general government, or borrow more money.

That’s without getting close to a discussion of entitlement reform (where Democrats will argue that Social Security does not need reform, and health care costs have to be controlled, and not just for the public sector.

@Mitch
The problem is that still assumes the answer. I agree that people say they want the spending; they also say they do not want the taxes.
I see no way to determine which one of those they *really* want without substituting personal judgment. To say that what is (ie, 2000+), is what they wanted, because it happens to be what occurred, assumes that what happens is always exactly what the people want. That is not self-evident.
Anyway, no reason to belabour this; I just do not think the argument can be made for where the problem “primarily” falls without it reducing down to a personal judgment.

This is all based on the irrational fear of the “fiscal cliff”. As we’ve seen again and again, the tax increases on the wealthy will lead to serious economic growth. The cuts in non-defense spending will hurt, as they have a multiplier, but the defense cuts will only do limited economic damage. However, after a year or two of higher taxes, growth will pick up dramatically and spending can be restored. This is just a manufactured crisis that doesn’t need “solving”, least of all by changing popular programs that have nothing whatever to do with the budget deficit.

Well, there you have it. Both Boehner and McConnell have officially stated today there will be no increase in taxes. So much for JDH’s plea for compromise. There is no compromising with Republicans. So the only alternative is to let the Bush tax cuts expire in January and work from there. That is the only possible way of getting tax increases with obstinate Republicans.

OT: But could you chime in on the gasoline shortage in NY/NJ. I find it hard to believe that if gas prices were allowed to rise to $10 a gallon (which is what consumers pay in Europe anyway) that gas stations would not be able to find supply from areas that were not damaged by the storm. However, I do not know the gasoline transportation infrastructure (aka pipeline) well enough to be certain if this is feasible or not.

JosephBoth Boehner and McConnell have officially stated today there will be no increase in taxes.
Can you provide a quote?
They are talking about tax rates, not tax revenue. They prefer capping deductions. The result is that the “rich” pay more in taxes. That was one of Obama’s demands. Why are you against it? If Obama is going to increase taxes on the middle class and the poor then why didn’t he state those facts during his campaign?
You seem to be arguing that Obama wants to increase taxes on everyone.

Here’s your quote Joseph. Facts trump crap.http://news.yahoo.com/obama-americans-agree-approach-deficit-183016532.html
The president, speaking in the White House East Room, said he wasn’t wedded to every detail of the plans he outlined during the election, adding, “I’m open to compromise.” But he offered no indication that he was willing to back down on his insistence that the wealthy pay more.
Republicans stood their ground. At the Capitol, Republican House Speaker John Boehner said he remains unwilling to raise tax rates on upper-income earners. But he left open the possibility of balancing spending cuts with new revenue that could be achieved by revising the tax code to lower rates and eliminate some tax breaks.

Read between the lines. This is how deals get done.
What is Boehner supposed to say? “50% of the country has spoken, we must bow to your almighty and perfect plan to rule America.”
Give me a break…

tjThey are talking about tax rates, not tax revenue. They prefer capping deductions.
More Republican bait-and-switch. We went down this path once before, remember? Back in 1986 the agreement was lower rates in exchange for fewer deductions. The ink was barely dry before the GOP and Rostenkowski Democrats were wheeling-and-dealing another set of deductions for Big Daddy Campaign Buck$ types. Why do you think this deal would be anymore permanent? What the Republicans are offering is a sucker’s deal.
In case you didn’t hear the news, the GOP just took a thump’n. They lost the Presidential race. They lost seats in the Senate. And if we still had the 2010 congressional districts they would have lost control of the House as well. The only reason they still control the House is because of gerrymandering at the state level. It’s time the GOP learns its place in the greater scheme of things. As Jon Stewart pointed out, Mitt Romney was just elected President of the Old Confederacy.

I think we need to turn Nate Silver and his peers onto this problem: are Americans really as anit-tax as proclaimed by the Republicans (or at those on the right, who get the most media play)? I suspect not, that the issues affecting swing voters are much more diverse. The median voter comments get at this, but I’m pretty sure we have direct evidence from various opinion polls over the years, carried out in different ways and with different samples. Exactly the type of data that cries out for the meta-analysis of Silver and others.

2slugs
Wow, you have to go back to 1986 to support your claim!? Obama is the master at bait and switch. (e.g. you can keep your doctor)They lost the Presidential race. They lost seats in the Senate. And if we still had the 2010 congressional districts they would have lost control of the House as well.
LOL! ~10 million fewer votes for Obama this year than 2008.
If you want to get rid of gerrymandering that works for me. Without it, we wouldn’t be in the mess we are in today with lifetime democrats in certain “liberal” districts.
What’s wrong with closing loopholes so the rich pay more in taxes and the highest earners in the 47% who pay $0 in federal income tax start paying something?
You lose all your credibility if you think we can solve our fiscal problems with only half of us paying federal income tax.

“Any objective observer can see that this calls for both tax increases and entitlement reform.”
I get really tired of statements like this. Taxes and entitlement reform are political questions, which are left to the voters. As long as the laws of arithmetic are not breached, it is theoretically possible to address our fiscal challenges without tax increases or without entitlement reform. By the way, the voters have spoken in favor of higher taxes and against entitlement reform. But anyway, an objective observer would make a descriptive argument, not a prescriptive one. There is a difference between being apolitical and a political moderate. But apparently this subtlety is lost on some people.
As for dr. Hamilton’s fancy graphs showing entitlements are a raging menace to our fiscal health: the recent big jump is surely not the result of a sudden surge in Medicare recipients. OK, the baby boomers are retiring, but more important is the late 2000s recession, which has added millions of Americans to jobless programs. It’s not enough to know the numbers and be able to perform advanced statistical techniques on them, one has to study the issues behind the numbers. This is what people like the “reckless and stupid” (according to Dr. Hamilton, who, when last I checked his CV, is more of an econometrician and energy expert than a sterling macro-economist) Paul Krugman regularly do.

Having learned graduate macro for JDH, I think he is a sterling macro-economist. A business cycle expert too.
How does a recession add to Medicare expenses? This is largely a age linked program (except for the disability part). The increases come largely from more old people and health care cost increases. The latter is a real problem.
My advice is avoid taking swipes at individuals-both Krugman and Hamilton, who are three standard deviations away from the mean in terms of talent and work ethic.